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Status Review of SEC's Proposed Corporate Disclosure Rules

ESG - climate disclousre rules, SEC

The Securities and Exchange Commission (SEC or Commission), in 2022, issued proposed rules governing disclosure of climate change and its effect upon corporate entities. The Commission solicited public comments on the proposed rules from investors, Registrants, and other market participants. Comments requested by the Commission included those relating to how the Commission could best regulate climate change disclosures in order to provide more consistent, comparable, and reliable information for investors; whether the Commission should require the disclosure of certain metrics and other climate-related information; what role the existing climate-related disclosure framework should play in the Commission’s regulation of such disclosure; and how corporate disclosure should be subject to formal assurance requirements. Following its review of the public comments, the Commission will issue modified rules. Although it initially planned to issue these modified rules by the end of 2022, as of the date of this article, no modified rules have been issued. This article provides a general overview of the Commission’s proposed rules, briefly describing the rules, the Commission’s rationale for requiring disclosure, and the regulatory framework. It is intended to lay the groundwork for a more detailed review of the modified proposed rules when they are issued.

The proposed rules are issued pursuant to the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). Titled “The Enhancement and Standardization of Climate-Related Disclosure for Investors,” the proposed rules require Registrants to disclose climate-related information that would be reasonably likely to have a material impact on a Registrant’s business. Given the potential impacts of climate-related risks on Registrants, and the inadequacies of current climate disclosure protocols, the Commission proposes to include in the disclosure rules climate-related disclosure items and metrics that are necessary or appropriate to protect investors. For example, Registrants will be required to disclose any climate-related impacts affecting their business operations, products, or services, affecting suppliers and other parties in their value chains, affecting activities undertaken by Registrants to mitigate or adapt to climate-related risks (including the adoption of new technologies or processes), affecting expenditures for research and development, and affecting any other significant changes or impacts affecting business operations. For each such risk or impact, Registrants also must disclose the time horizon (did the impact occur in the short, medium, or long term?) and how they have considered the identified risks/impacts as part of their business strategies, financial planning, or capital allocation. Finally, Registrants must provide both current and forward-looking disclosures to facilitate an understanding of whether the potential climate-related risks have been integrated into Registrants’ business models or strategies and how resources are being used by Registrants to mitigate such risks. 

The Commission defines a number of terms used in the proposed rules. For present purposes, it is important to understand “climate-related risk” and “physical risk” to understand the Commission’s disclosure requirements. Climate-related risk is defined as the actual potential negative impacts of climate-related conditions and events on a Registrant’s consolidated financial statements, or in its business operations and value chains. Climate-related risks can include climate events and contingencies that pose financial risks to Registrants. A Registrant also would be required to disclose the material impacts of physical risks on its strategy, business model, and outlook. Physical risks may include harm to businesses and their assets arising from acute climate-related disasters such as wildfires, hurricanes, tornadoes, floods, and heat waves. The proposed rules also require a Registrant to specify whether an identified climate-related condition is a financial, physical, or transition risk, to allow investors and Registrants to better understand the nature of the risk and make plans, as appropriate, to mitigate or adapt to the risk. If it is a physical risk, the Registrant would be required to describe its nature, including whether it is acute or chronic. For example, a company’s investors may face chronic risk and more gradual impacts from long-term temperature increases, drought, and sea level rise. Such risks also may be associated with a potential transition to a less carbon-intensive economy, resulting from changing consumer, investor, and employee behavior and choices, changing demands of business partners, changes resulting from long-term shifts in market prices, changes associated with technological challenges and opportunities, and other transitional impacts. 

The Commission intends to implement the proposed climate rules by adding two new subparts or sections to its current regulations. The first, to be added as a subpart to Regulation S-K, 17CFR 229.1500-17 CFR229.1507, focuses on a Registrant disclosing certain climate-related information about climate-related risks that are reasonably likely to have material impacts on its business or consolidated financial statements, including greenhouse gas (GHG) emissions metrics that could help investors assess those risks. The second, to be added as a new article to Regulation S-X, 17CFR219.14-01-17/CFR 219,14-02, focuses on the Registrant including certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements. 

The regulatory framework established by these new rules highlights two categories of rules imposing regulatory obligations. To facilitate understanding of these two new Sections, and this new regulatory framework, the Commission’s rules can be characterized into two categories: administrative rules and disclosure rules. Administrative rules address issues relating to the regulatory framework and the organizational structure and procedural obligations of the proposed rules, imposing specific presentation requirements upon Registrants. The disclosure rules, on the other hand, impose substantive disclosure obligations on the Registrant. 

The Commission provides the following list of examples of administrative rules, presenting examples of the types of rules considered “administrative”:          

  1. To provide climate-related disclosure in its registration statements and Exchange Act annual reports.
  2. To provide the Regulation S-K mandated climate-related disclosure in a separate, appropriately captioned section of its registration statement or annual report, or alternatively to incorporate that information in the separate, appropriately captioned section by reference from another section.
  3. To provide the Regulation S-X mandated climate-related financial statement metrics and related disclosure in a note to the registrants audited financial statements.
  4. Electronically tag both narrative and quantitative climate-related disclosures.
  5. File rather than furnish these climate-related disclosures.

Unlike the administrative rules, the “disclosure rules” are substantive and include disclosure requirements designed, as noted above, to foster greater consistency, comparability, and reliability of information. Disclosure is required for a number of climate-related conditions, and is mandated in a number of situations prescribed in the rules, requiring Registrants to collect and disclose a broad range of climate-related information in Annual Statements and other financial documents. Disclosure obligations include “phase-in” periods for the proposed disclosure requirements, a “safe harbor” for certain emission disclosures, and, for smaller reporting companies, certain “exemptions” from applicable requirements. 

As substantive obligations, the disclosure requirements are being proposed because it is believed they will provide “consistent, comparable, and reliable” information to investors, enabling them to make more informed judgments about the impact and potential impact of climate-related risks on current and prospective investments. The Commission states that the way a company assumes responsibility for and plans for climate-related risks likely will have a significant impact on its financial performance. “Disclosure” is considered important because climate-related risks can affect a company’s business and financial performance. For example, severe and frequent natural disasters can damage assets, disrupt operations, and increase costs. Further, business changes undertaken to lower carbon products, practices, and services, triggered by changes in regulation, consumer preferences, the availability of financing, technology, and/or other market forces, also can adversely impact a company. The SEC determined that such disclosures will be in the public interest and protect investors. The Commission also listed the following disclosure rules as examples:

  1. The oversight and governance of climate-related risks by the Registrant’s board and management.
  2. How any climate-related risks identified by Registrant have had, or are likely to have, a material impact on its business and consolidated financial statements, which may manifest over the short, medium, or long term.
  3. How any identified climate-related risks have affected or are likely to affect, the Registrant’s strategy, business model, and outlook.
  4. Registrant’s process for identifying, assessing, and managing climate-related risks, and whether such processes are integrated into Registrant’s risk management system or process. 
  5. The impact of climate-related events affecting financial statements and related expenditures, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities.
  6. Scopes 1 and 2 GHG emissions metrics, separately disclosed, expressed as follows: (1) Both by disaggregated constituent greenhouse gases and in the aggregate, and (2) In absolute and intensity terms.
  7. Scope 3 GHG emissions and intensity, if material, or if the Registrant has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.
  8. The Registrant’s climate-related targets or goals, and transition, if any.

Particularly given the Commission’s current review of the public comments, the proposed rules are still in development, and presumably being modified, and only can be discussed in generalities. An example of incomplete rules is given by the Commission with respect to attestation requirements. The attestation rules currently require certain large or accelerated filers to include in the disclosure report an attestation report covering the disclosure of certain emissions and related disclosures. Although still only a generality, the Commission commits to provide “transition periods,” which will provide the Registrant time to prepare these disclosure materials and provide minimum attestation report requirements and minimum standards for an acceptable attestation framework. The Commission also suggests it may impose certain minimum qualifications on service providers.

The proposed regulations are not the SEC’s first attempt to address climate change. The SEC issued several interpretive releases during the 1970s, stating that Registrants should consider disclosing in SEC filings the financial impact of compliance with environmental laws. In 1982, the SEC adopted rules mandating disclosure of information relating to litigation and other business costs associated with compliance with environmental laws. In 2010, the SEC issued guidance indicating that climate-change disclosures may be required in SEC filings. Registrants also were warned to evaluate their climate-related risk and assess whether disclosure relating to those risks must be disclosed in their Description of Business, Risk Factors, Legal Proceedings, and MD&A. 

After these previous attempts, why has the SEC proposed new regulations now? According to the SEC, two recent, significant developments explain the Commission’s proposed climate-related reporting rules. The first involved the Task Force on Climate-related Financial Disclosures (TCFD), which independently developed a climate-related reporting framework that is now widely accepted and used by Registrants and investors. As noted, the SEC has modeled its proposed disclosure rules in part on the TCFD framework, supplemented by components of the Greenhouse Gas Protocol, purportedly allowing companies to leverage the disclosure framework in a way with which they are familiar. The TCFD framework establishes two broad categories of financial impacts driven by climate-related risks and opportunities:  (1) financial performance (income statement focused) and (2) financial position (balance sheet focused). Certain metrics, such as the amount of capital expenditure deployed toward climate-related risks and opportunities, also were incorporated into these two categories. The second development identified by the SEC involves the Greenhouse Gas Protocol. As noted, it has become a leading accounting and reporting standard for greenhouse gas emissions and is used in conjunction with the TCFD framework.

The complexity of the proposed rules, and the numerous comments and threatened challenges to these rules received by the Commission, likely are responsible for the Commission’s delay in issuing modified rules. For those reasons, it is also likely that the proposed climate-related rules, and any modified rules, will only be the beginning of a long process.

Disclaimer: This post does not offer specific legal advice, nor does it create an attorney-client relationship. You should not reach any legal conclusions based on the information contained in this post without first seeking the advice of counsel.

About the Author

Stephen C. Jones is Senior Counsel in the firm's Environmental Practice Group. He has practiced environmental law for over 25 years and represents venture capital and private equity investors, real estate opportunity funds, private developers, chemical, health care, energy, and manufacturing companies, among others. Mr. Jones is admitted to practice in Pennsylvania, California, and Washington, D.C.

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